Having spent months negotiating the deal, EDS’s management team backed off from the contract within a matter of days, arguing that the deal was too risky. “The decision to terminate discussions was made after careful consideration of the overall transaction requirements, and more specifically, the acquisition price sought by P&G for intangibles associated with the related business assets,” the company said in a statement.
In fact, EDS’s decision to pull out owed more to its exposure to telecoms giant Worldcom, which is close to collapse following the revelation of a $3.8 billion fraud. EDS has admitted that, in the period to the end of June, it will book $150 million in revenues from
its ongoing contract to handle outsourcing for Worldcom for which it has not been paid. EDS has yet to even bill Worldcom for $60 million.
These problems have focused attention on how EDS and other large outsourcing service suppliers book revenues and expenses from large contracts. Under a system called ‘percentage of completion’ accounting, EDS books some revenue from large contracts before it is billed, and spreads its own costs out over the course of the contract. In this way, it avoids posting huge losses in the early years of a contract when initial outlay costs are high. Nor does it report excessive gains in the latter years of a contract, when its returns from the project are high.
However, analysts believe that EDS needs to balance these complicated transactions with a more steady stream of revenues from smaller projects with faster returns that do not entail big initial expenses and complex accounting.
This is not to say that EDS will no longer pursue large, multi-year, multi-billion dollar contracts. It is already vying with IBM Global Services for a huge contract with financial services company JP Morgan Chase, which may be worth as much as $2 billion a year.
What it does signify, however, is that EDS’s management has recognised the need to spread its risk more evenly. And to do so, it will target two key growth areas: small and medium-sized enterprises (SMEs) and public sector organisations.
According to company chairman and CEO Dick Brown, EDS is already successfully targeting SMEs. The company, he boasts, has “the largest pipeline of potential new deals we’ve ever had.” Much of this new business, he says, is coming from smaller organisations than EDS has sold to in the past.
This is the result of a concerted effort at EDS to appeal to SMEs, argues Bryne Mulroney, the EDS executive in charge of partner relationships. He points out that the company created an indirect channels organisation two years ago to make a bid for this segment, and has been able to take advantage of both its own strength in systems integration and the strength of these new partners in finding “front-end routes to new markets”.
EDS is already strong in the government sector. According to Peter Foster, an analyst at research company Ovum Holway, it is the top IT services supplier to the government sector in the UK, with three times the revenue of its nearest competitor, Capita. He adds that the top ten IT services companies saw public sector sales grow by an average of 15% in 2001, nearly double the rate of other sectors.
In the UK public sector, EDS has had a contract with the Inland Revenue for 10 years, has developed systems for the benefits systems, and is developing a payroll system for the Ministry of Defence (MoD). The company is also negotiating for the contract to provide an email directory service and email access for everyone employed in the NHS, a scheme planned to start at the beginning of 2003.
However, EDS has come under fire for being late with its MoD and Inland Revenue contracts, and massively exceeding the budgets set for these projects. David Fisher, strategy director for EDS UK, counters that the UK government has been adding requests for more features to the contracts, and that EDS is not inflating the costs. In fact, costs have dropped dramatically, he claims.
EDS’ acquisition of web hosting company Loudcloud in June may boost its public sector sales, given that Loudcloud hosts the UKonline.gov.uk government information web site. More important, it may attract new European customers that are finding it increasingly difficult to find a reliable, financially stable web hosting provider that isn’t compromised by the fortunes of a parent company from the troubled telecommunications sector. The CIO of a major UK media company says of the challenge of selecting a web-hosting provider: “IBM is the only choice left in Europe.” As a result, EDS may be able to break into this area.
One thing is clear, however: EDS must find growth opportunities. While overall revenues in 2001 were up 12% to $21.5 billion, 2002 has been harder, and in early July, it announced plans to lay off 2,000 people in response to sluggish demand.